We know that when we invest our money, we get returns, measured either in absolute amounts or as a percentage of our investment. But what exactly is a return? We part/lend our savings to someone, who borrows it and pays us a small sum until they return our entire money back. This small sum is called return, which could be periodic or single lumpsum repayment.
How do we decide if a return is good?
Before we attempt to answer this question, lets look at some returns that we’re familiar with.
- Kala lends her savings to a bank as Fixed Deposit & the bank returns her 7%
- Ram invest in stocks & the company pays him a dividend of 1.5%
- Mangai buys gold & gets no return till she sells it
- Siva rents his Rs.60 Lacs apartment/house and gets Rs.15,000/- p.m, i.e, rental yield of 3%
- Arul buys a plot of land & gets no return till he sells it
If we compare the percentage returns of the above people, we would be inclined to conclude that Kala’s FD is the best investment & Mangai’s gold and Arul’s plot as the worst. But somehow we know this is not the case, why?
Cash (vs) Capital Asset
The answer lies in the nature of the asset – FD is a cash asset, while the rest are capital assets. We believe that capital assets appreciates in value over time and hence choose to accept a relatively smaller return (dividend or rent) or even 0% return (gold) from these assets. On the other hand, FD being a cash asset, it does not appreciate in value and hence we expect a higher return.
Even amongst the capital assets not all returns are alike. Capital assets appreciate based on demand-supply dynamics and hence the rate of appreciation is not predictable – in certain years they return 50% and in others they return only 3%.
Ram may be lucky to generate a 30% return from stocks in a rally year like 2018, but he may not be able to repeat it consistently year after year. Similarly, Arul may have sold his Rs.5L plot of land for Rs.30L in 10 years, but he may not be able to sell that Rs.30L plot for Rs.2 Cr in the next 10 years.
How do I measure my returns?
Lets say your total asset holding is Rs.1 crore – Rs.60L house on rent, Rs.5L plot, Rs.5L in stocks and Rs.30L in FD/EPF/PPF). Your total returns per annum would be Rs.5.13L, at 5.13%.
|Asset Description||Asset Purchase Value||Asset Weight||Asset Returns p.a||Asset Return Absolute Amount||Weighted Asset Return|
|1. Rental Property||₹6,000,000||60.00%||3.00%||₹180,000||1.80%|
|2. Plot of Land||₹500,000||5.00%||20.00%||₹100,000||1.00%|
|4. Fixed Deposit/EPF/PPF||₹3,000,000||30.00%||7.50%||₹225,000||2.25%|
|Total Portfolio Value||₹10,000,000||₹512,500||5.13%|
Although you generated 20% returns by sale of the plot of land, it forms only 5% of your assets. Now, if you would like to generate 20% return on your entire portfolio of assets, it requires you to invest the entire Rs.1Cr in just one asset class – in plots of land, which is not preferred as you would like to diversify your risk. Similarly you may not invest all of Rs.1Cr in gold nor stocks for the same reason. So, it is important to understand total returns of all your money and not be carried away by a single asset’s high return.
So, What makes a good return?
A good return is not about making windfall gains in one transaction. It is about making each drop count. Jerky returns are like flash floods, they come & go, but they do not fill your wells. Consistent and steady returns over many years is the secret to building long term wealth. A good return is one that gives us inflation-adjusted income + a reasonable appreciation over a long term. Is there a magical number to measure good return? We shall explore in the next issue..